Facebook positions itself as a financial services provider
There is currently a lot of movement in payment traffic, not only due to the increased volumes of cashless payments triggered by Covid-19but also by the discussion around digital currencies. This discussion was launched by the Libra Association in June 2019, which was initiated by Internet giants such as Facebook, Spotify, Uber, Shopify and Lyft. Declared goal of Libra is to create a global financial infrastructure and unimodal payment system that will give billions of people access to financial services, especially in so-called underbanked nations, i.e. countries without a functioning banking system.
This private-sector and consortium initiative has stimulated a public debate, as it could have a significant impact on monetary policy and would re-sort the global payment traffic. Central banks around the world have since been working at full speed on their own solutions for digital currencies, known as Central Bank Digital Currencies (CBDC). Will Libra outstrip the central banks? What role will banks play in the payment transactions of the future? Will there be a winner in the end or will different solutions for different applications coexist?
Accounts and payments – where is the connection?
First of all, many readers will certainly ask themselves what innovation Libra, CBDCs and other digital currencies actually bring with them, since it is already possible to pay digitally without any problems, whether via smartphone or even Smartwatch. Basically we have to differentiate between currencies and payment services. Paying with a smartphone always depends on the bank’s infrastructure.
Even if the credit card has been deposited, in the end the account at the bank will be charged. This means that the payment service providers merely provide the marketplace, but are bound by the acceptance of the banks. Applied to the perspective of “whatsapp payment” or “from smartphone to smartphone”, this means that card providers cannot settle amounts. To make this possible, the bank account that solves a transfer (claim against the house bank) must be deposited. For a “Whatsapp payment”, real-time transfers with automatic clearing would therefore be necessary. With SEPA Instant Credit Transfer (SCT-Inst), a payment infrastructure should be created that settles amounts in real time (approx. 10 seconds) and enables direct value date with the customer account.
In addition to the horrendous costs for the conversion of the core banking system and a 24/7/365-day operation of the technical infrastructure, another problem is that the offer can only be brought to the market by third party service providers (payment service providers). For Whatsapp payments this would be Facebook, for smartphone payments the relevant providers (Apple, Android, etc.). This means that the banks will have to amortise the costs for the conversion of their core banking system, with third-party providers benefiting most from this, as they can offer their customers an additional feature.
The consumer in focus (B2C Payments)
Banks have largely lost access to the end consumer compared to fintechs such as N26, Klarna, Transferwise and Co. and fear that the continuing low interest rate policy will lead to a widespread “stunting” of clearing houses and custody providers for customer-focused “digital native” companies. The attempt by banks to use SCT-Inst to get closer to their customers again has proven to be a Herculean task and, unfortunately, is not having the desired success, as the costs of the conversion cannot be amortised.
With Libra, another competitor is now coming into play, which not only offers its own payment system, but also has the critical mass of users to establish this as standard. The range of a Whatsapp payment, with which you can settle your Amazon bill and pay for a piece of cake at the café around the corner, can only be guessed at. Accordingly PayPal, Mastercard and Co. are under pressure to place a better offer on the market. However, since Libra is not questioning the euro as a currency, but is merely providing a new payment network for it, banks can observe the market dynamics here in a relaxed manner, as it does not change anything about their function as gatekeepers of customer accounts and settlements.
What about business? (B2B and Corporate Payments)
Much more exciting is now the question of what will happen in the B2B environment. For years, B2B payment transactions have been treated rather shabbily and largely consist of the classic SEPA transfer. Occasionally, corporate credit cards are still used for individuals; the direct debit mandate plays a minor role. However, business customers are demanding new payment options, which is shown by the fact that the Billie start-up company has already made a breakthrough in the factoring sector.
Furthermore, many German industrial manufacturers are working on usage-based billing of their products (pay-per-use) instead of pure sales, in order to earn money in the Silicon Valley manner from Monthly Recurring Revenue Streams. This opens up new markets and business models for banks. From the bank’s point of view, the question must now be asked how it intends to exploit this market. On the one hand, the SEPA Inst infrastructure that has been created can be used to meet this demand, but it leaves the customer interface back to “payment service providers” without any real added value or new business model.
“From the bank’s perspective, the question now is how to play this market.”
In addition, there is a risk that third-party providers with programmable payments will quickly take over the market. The second and more lucrative option for banks would be to use a digital currency for direct payment settlement and integration into customer systems. In this way, they would be given an active role in payment transactions and would also be the face to the customer. This option thus offers banks a completely new business model and builds a bridge between Industry 4.0 and financial services.
Status Quo – What is money?!
It is clear from the above paragraphs that the actual balancing of accounts and the money involved is the “causus crackus”. With a digital currency that enables programmable payments, banks can once again play an active role in payment transactions and especially in the as yet untapped B2B market. But what forms of money do we already use today and what could the solution for a digital currency including programmable payments look like?
- Central bank money exists in two forms: on the one hand as cash created by the central bank, which is also a legally guaranteed means of payment, and on the other hand as central bank deposits of the commercial banks. Central bank balances arise, for example, when the central bank grants a commercial bank a loan or buys assets such as government or corporate bonds.
- Commercial bank money (also book money or bank deposits) is not only the most important type of money in practical terms in terms of money supply, but is also an elementary component of the credit-based money creation by commercial banks. It arises outside the ECB’s immediate sphere of influence and (merely) represents a claim of the customer against the bank. Thus, commercial bank money only appears in the banks’ books and is covered by a minimum reserve of the commercial banks at the central bank. This type of money is the basis of cashless payment transactions (keyword: credit transfer), but does not constitute a means of payment by the state.
How does money become digital?
Central bank money and bank deposits are available in electronic form, but are not digitised. This small but subtle difference becomes even more apparent in English. Here there are two terms for the word “digitization”: digitalization and digitization. Digitization describes the use of digital technologies to map formerly analog processes in the digital world.
For example, analogue payment transactions (cash payments) are digitalised by our current payment system (bank transfers). As a result, value transfers in digital form and thus over long distances can be carried out easily and efficiently. However, the money itself is not digitized. Digitization describes the conversion from analog to digital; a physical document can be transformed into a digital document by a word processing program, for example. With the help of Distributed Ledger Technology[AB1] , (i.e. distributed database structures), money itself can now be digitized and made available in token form for the first time. Bitcoin and the underlying block chain technology were the forerunner here.
So how can the euro be digitised? In principle, this is possible for both central bank money and scriptural money. 80 % of central banks worldwide are working on a digital central bank currency (CBDC). The digital yuan is already being tested in China and the ECB also made its first statement on a Euro CBDC in October. The focus of existing CBDC concepts is on providing digital cash to end users. Thus, it is primarily intended to serve the B2C use case.
So the more interesting B2B use case is still waiting for a solution. Here is an opportunity for the banking sector and the bank deposits. First attempts to digitize bank deposits have already been made with the help of the e-money license. However, e-money tokens have a major disadvantage: they are not multi-bank-capable and also not scalable. An e-money token from Bank A is usually not accepted at Bank B. And even if this were the case, another problem arises: tokens issued by different banks are not fungible. This is because the issuer of the e-money is liable for it. If Bank A is more trustworthy than Bank B, it can happen that the e-money tokens of the two banks have an exchange rate to each other and therefore not a 1-to-1 peg to the (central bank) euro. This would lead to the sudden existence of different “Euros”, comparable to the different USD stablecoins like USDT, USDC, etc.
This problem of fungibility can be solved by requiring all banks to collateralise 100 % of their tokens with central bank reserves and hold them in escrow accounts at the ECB. Credit risk is thus practically eliminated and a 1:1 peg to the euro is guaranteed. This concept, which in effect is a stablecoin issued by banks, is referred to by the International Monetary Fund (IMF) and the Bank for International Settlements (BIS) as synthetic or indirect CBDC (sCBDC).
An sCBDC also has several other advantages over a CBDC. Because an sCBDC is a token from the private sector, the relative strengths of private companies can be played out. These include innovative strength, agility and efficiency. In addition, there are fewer economic risks than with a CBDC, since the monetary cycle as a whole undergoes little change. Similar to today’s book money, the actual creation of money happens at the level of commercial banks. In the case of an sCBDC, only the underlying technical infrastructure is changed, but the risks are manageable due to the fact that the money is tied to central bank money.
Ultimately, the biggest hurdle with this solution is that the commercial banks must agree on a technical standard that is accepted by all participants in order to achieve multi-bank capability and scaling. Once this technical standard has been set, nothing stands in the way of innovative business models in the B2B sector, such as pay-per-use. New business models emerge from the close collaboration between banks and the industry. This offers a unique opportunity for Europe to become competitive again on a global level when it comes to digitalisation.
Source:
[AB1]https://wirtschaftslexikon.gabler.de/definition/distributed-ledger-technologie-dlt-54410
